Once Weak, U.S. Banks Ride High

Posted June 22, 2018 6:49 p.m. EDT
Updated June 22, 2018 6:52 p.m. EDT

What a time to be a bank.

After making it through the annual, government-run stress tests Thursday, the largest U.S. banks could soon be free to pay out as much as $90 billion in spare profits to their shareholders.

That banks are in such a position highlights the remarkable change in fortunes for an industry that was on life support a decade ago.

Banks have more than doubled their capital, their main financial defense against losses. Profits are surging on the back of the stronger economy, and bank stocks have risen more than the broader stock market since the election of Donald Trump. Wall Street’s chief executives are enjoying hefty paydays. The Trump administration has started to relax post-crisis regulation, and banks are angling for more loosening. Lenders are embracing exciting new technologies that could revolutionize parts of their industry.

“You guys thought I was kidding when a few years ago I said you can have a golden age of banking,” Jamie Dimon, chief executive of JPMorgan Chase, said this month, taking stock of trends in the industry. “I mean, you’re going to have a golden age of banking. You have a golden age of banking.”

But the resurgence of the industry is a refutation of those who predicted the post-crisis regulations would hamstring banks and damp the economy. Banks are not only safer than they were before, they are back to earning strong profits.

The largest financial institutions find out for certain next week if the Federal Reserve has signed off on their plans to distribute capital to shareholders. The results Thursday suggest that most will get what they want. Analysts at Barclays forecast that the banks, on average, are in a position to distribute all their profits to investors. Banks can do this because they have quite a bit more capital than regulators require.

Critics of the industry say the banks should be lending that money out or retaining it to strengthen their balance sheets. But Dimon rejected such assertions in an interview.

“If you look at the growth of capital overall, it’s extraordinary,” he said, “It isn’t fair as a blanket statement to say paying out is bad. Many banks have a huge amount of capital they can’t deploy right away.”

After the crisis, policymakers believed that making the banks stronger would bolster their lending. In many ways, this outcome has occurred. Since the end of 2010, banks have added $2.5 trillion of loans, a 37 percent increase, according to data from the Federal Reserve. Over the same period, their profits have soared. In the first quarter, the industry as a whole reported its highest profits in recent decades, according to data compiled by Federal Deposit Insurance Corp.

The six largest U.S. banks — JPMorgan, Bank of America, Citigroup, Wells Fargo, Goldman Sachs and Morgan Stanley — have done particularly well. They made $141 billion in pretax profits in 2017, nearly double the $75 billion they made in 2010. The tax cuts enacted last year have provided a particularly large lift to the bottom lines of banks. A strengthening economy and higher interest rates are expected to further increase earnings this year.

Those behind the post-crisis regulatory overhaul say the robust economy shows that more or less the right amount of regulation was imposed. Barney Frank, the former congressman who helped sponsor the Dodd-Frank Act, said, “I have been struck ever since Trump came into office by his bragging that we have the best economy that ever existed anywhere and his insistence that regulation was damaging the financial sector.”

The stress tests suggest that the banks can withstand punishing losses. They assume, for instance, that Bank of America can suffer $50 billion of losses on its loans and still have ample capital.

But good times in banking can lead to complacency among regulators and bankers. So while banks are definitely stronger, some prominent skeptics would prefer that more be done to make sure taxpayers are never called on again to bail out the banks.

“The question is not: How do banks perform when the economy is strong?” Neel Kashkari, president of the Federal Reserve Bank of Minneapolis, said in an interview. “The question is: How do banks perform if there is a major economic downturn? And our analysis at the Minneapolis Fed says that the banks are still too big to fail.”

Kashkari, who was a Treasury official during the crisis and oversaw the government’s bailout of the banking industry, said he believed that a crucial part of regulators’ post-crisis plans for winding down failing banks — turning a bank’s debt into equity — would not work in a real crisis. To stop a collapse of the system, he said, taxpayer bailouts would almost certainly be required. Instead, regulators should have banks substantially increase their equity, Kashkari said.

Banks would no doubt oppose such a move, saying it would make certain businesses unprofitable. But he said, “If the banks’ business model requires taxpayer support, then they don’t have a business model that works.” With Trump’s appointees now filling the most powerful bank regulatory posts, there is little expectation that the rules will get stricter. In recent months, the regulators softened one important capital requirement, known as the supplementary leverage ratio, and relaxed aspects of the Volcker Rule, which was meant to prohibit banks from trading for their own profit.

Investors hope deregulation will reduce the costs of complying with rules, give banks more freedom to pursue profitable business and allow them to pay out even more capital. Such hopes have helped drive bank stocks, measured by the KBW Bank Index, up 44 percent since Trump’s election, compared with 29 percent for the S&P 500.

Bankers assert that they do not want a wholesale dismantling of the post-crisis rules. Instead, they say, they want to refine rules to make lending less costly and cumbersome. Mortgage lending, for instance, is one area that could benefit from looser rules, some banking experts contend.

“People say the banks are doing well, so we don’t need to change,” said Phillip L. Swagel, a professor of international economic policy at the University of Maryland and a Treasury official during the administration of George W. Bush. “But, no, if we can do it better, then let’s make it better.” But critics of the banks say the banks could be doing more under the current rules to expand whom they lend to, especially when they have so much spare capital. Michael Calhoun, president of the Center for Responsible Lending, said deregulation could lead to less lending. He asserted that possible changes to the Community Reinvestment Act could reduce the presence of banks in certain less well-off areas.

“Is it too much for banks to provide basic banking services in their footprint?” Calhoun asked.